What is Tokenization? The Keys To Understanding It
Many organizations use encryption to protect their data at rest. Although it is a quite valid method to protect your data, there are others with more projection and possibilities.
We are talking about tokenization, which makes it possible to convert plain text into a token value that does not reveal the sensitive data being tokenized. We tell you what it consists of, its uses, and how to tokenize assets.
What is Tokenization?
Tokenization is the process of replacing sensitive data with unique identification tokens that retain all the essential information in the data without compromising its security.
A token is a piece of data that has no meaning or relationship to the original sensitive data. It acts as a carrier for plaintext, thus allowing data to be used in a database without revealing the information it protects.
Tokenization, therefore, seeks to minimize the amount of data a company needs to have on hand and to strengthen the security of credit card and e-commerce transactions. It minimizes the cost and complexity of complying with industry standards and government regulations.
Uses and Benefits of Tokenization
Tokenization has many uses, and the main one concerns the financial sector: protection of credit card information, social security numbers, bank account information, or other payment data.
This card payment sector uses tokenization instead of encryption methods because of its simplicity of implementation and cost-effectiveness compared to other methods of protecting sensitive data.
This is why tokenization provides many benefits:
- A high degree of difficulty attackers face when attempting to steal tokenized information.
- Even if data is stolen, sensitive data cannot be reverted to its normal form, making it useless to attackers.
- Works well with legacy systems, even if an application or database has been created and used for decades.
- Uses fewer resources than encryption and is less likely to fail.
- Reduces the steps required for PCI DSS compliance for merchants.
- Facilitates payments by using new technologies (mobile wallets, one-click payment, or cryptocurrencies).
- Increases customer confidence by improving security and convenience of service.
Tokenization vs. Encryption
Tokenization and encryption are often mentioned together as means of protecting information that is transmitted online.
Both help to comply with data security policies as well as regulatory requirements for organizations. However, each has its strengths and weaknesses, so you need to know which one is best suited to your needs at any given time.
These are the main differences:
Tokenization and Blockchain
If we look at this system in the blockchain ecosystem, tokens are assets that allow information to be transferred, stored, and verified in an efficient and secure way.
These tokens can take many forms and be programmed with unique features that expand their use cases (security tokens, utility tokens, cryptocurrencies, etc.).
We have already explained what tokenization is, but in the context of blockchain technology, it can be defined as the process of converting something of value into a digital token that can be used in a blockchain application. These can take two forms:
- They represent tangible assets: gold, real estate, art, etc.
- They represent intangible assets: property rights, content licenses, etc.
This is why virtually anything can be tokenized when it is deemed to have value to someone, a meaning of possession, and an option to join a broader asset market.
In fact, the standard tokenization method is quite similar to that enabled by blockchain technology. However, blockchain-enabled tokenization makes it more secure and flexible, which increases the potential applications of digital tokens in a wide range of industries.
Tokenization is also closely linked to NFTs. The process of creating tokens to get NFTs uses blockchain technology, which allows you to store and exchange the tokens freely and securely, with a process similar to that of cryptocurrencies and blockchain-based assets.
After generating a non-fungible token of an asset, it can be included in an NFT exchange (if you want to sell your ownership later). Almost anything can be tokenized into an NFT, but how is it done? To tokenize an NFT, the following steps must be followed:
- Select the asset: Although you can tokenize virtually anything, it is best to choose something that will retain its value, such as artwork, music collections, patents, copyrights, etc.
- Identify the revenue model: When tokenizing your assets, you may want to list them on NFT markets to raise funds. In addition to buying tokens, you can also offer your services.
- Token economics: Refers to when you increase the value of an NFT by continuing to offer progress on the project you are funding and more people start converting.
- Create NFTs online: The most popular form of NFT is an ERC20 token on the Ethereum platform, but there are more. It can be a quick but complicated process to understand, and it’s best to have an experienced partner on your side.
- Legal regulations: If you are tokenizing an asset just for yourself, the regulations are simpler, such as following local laws on currency transactions, and paying the appropriate taxes or cryptocurrency laws. If the scenario is crowdfunding, you will need stronger legal documents.
- Escrow arrangements: If you want to maintain full control over your NFT tokens, the best idea is to manage your crypto wallet through an escrow platform.
- Token distribution: At this point, you need to distribute the tokens so that they can be purchased. There are events such as the ITO where these assets can be released, as it includes technical processing, ICO execution, and issuance of the actual tokens.
Tokens can be created in several ways:
- Using a mathematically reversible cryptographic function with a key
- Using a non-reversible function
- Using an index function or a randomly generated number
As a result, the token becomes the exposed information, and this sensitive information is securely stored in a centralized server (token vault). This is the only place where the original information can be mapped back to its corresponding token.
On the other hand, there are tokens without a vault. Instead of storing sensitive information in a secure database, vaultless tokens are stored using an algorithm. If the token is reversible, the original sensitive information is usually not stored in a “vault”.
Below, you can find some examples of tokenization in different sectors.
Art tokenization is one of the most promising at present. One of the most popular cases is fractionalization, especially in the case of more expensive artworks.
This process increases the investor base and makes illiquid assets liquid. What does this mean? Well, many assets are illiquid because they are expensive, and many investors cannot afford to buy them outright.
With tokenization, an asset can be divided into multiple tokens, where each token represents a portion of the asset and drastically reduces the minimum capital requirements for investors.
An example is the painting “Fillette au béret” by Picasso, which was priced at CHF 4 million, but has been split into 4,000 AST (Art Security Token), with a price of CHF 1,000 for each AST. This has made it possible to offer a little bit of art to a wider public that previously would have found it impossible to access such an exclusive asset.
Tokenized Real Estate
Real estate tokenization is gaining more and more followers thanks to the advantages it brings to issuers and investors. In fact, according to Atlas One, the real estate sector accounts for about 40% of the digital securities market, which is about $200 million.
This system converts the value of real estate into a token stored on blockchain, enabling digital ownership and transfer. These divisible tokens, much like NFTs, represent a fractional ownership stake in that real estate. In fact, there are several representations:
- The ownership of a portion of real estate
- Ownership of all of a property
- An equity interest in an entity that controls the property
- An interest in a debt secured by real property
At first glance, it may be difficult to visualize, but it brings with it advantages such as a lower barrier to entry, the ability to create liquidity, or reduced transaction costs.
It is the sector that faces the fewest barriers today, as token and credit purchases have been in place for decades. In fact, when NFTs were introduced, adoption was very natural on the part of players. They were willing to spend money on in-game credit, with the difference being that these are now recorded on blockchain.
Now that players can extract additional value from digital property, new use cases and utilities are likely to emerge that will be used well beyond entertainment in the future.
Tokenization makes the payment acceptance process easier and more secure. It also helps create seamless payment experiences and reduces the risk of data breaches.
Therefore, including such decentralized platforms in your business will allow users to create, manage and market their tokens.
At Plain Concepts, we have experience in asset tokenization for clients and NFT galleries. We provide you with a tool for building trust with your customers, minimizing red tape, and real-time benefits.